Purchasing real estate in a solo 401k is not that difficult as long as you follow the rules. As trustee of a solo 401k plan, you can invest in a number of real estate investments. These investments can include Apartment Buildings, Mobile Homes, Homes, Raw Land, Commercial Buildings, and more.
With a Solo 401K Real Estate, also called Self-Directed Solo 401K, various real-estate investments just mentioned can be held inside the 401K, much like mutual funds (stocks and bonds) are in a work-sponsored 401K. Most of these rules are similarly applied to cash balance plans.
In addition, with what is known as Tenancy-in-Common, as the business owner you can partner with your Solo 401K to invest in real estate. As you can imagine, there are rules to follow. One is that no debt can be used. Another rule is you cannot purchase a property that was previously owned by you or certain family members.
Loans are also permitted by a third-party, not the 401K owner or certain family members, in order to invest in real estate. By definition, this is called a non-recourse or debt-financing (more on this later).
Purchasing real estate in a solo 401k
The following information specifically relates to your Solo 401K being opened by a Provider as opposed to a Custodian. Going through a provider allows you to serve as Trustee for investments, as opposed to a Custodian which has their own set of rules and charges.
Rules when using the Solo 401K to Invest in Real Estate
- Know how much you want to spend
- Determine if the Solo 401K will need:
- Non-recourse Loan; or will
- Use the Tenancy-in-Common option
- Decide on and select the specific real estate
- If doing a non-recourse loan, obtain a lender
- Make an offer on the property
- Use a Title Company or an Attorney to create a required real estate purchase documents
- Be clear in communicating to the Title Company or Attorney that the purchase is being made through the Solo 401K, thus it will need to be listed as the buyer or purchaser
As the Trustee of your Solo 401K Plan, you must keep and store certain documents and forms related to the purchase. Those documents and forms include the following:
- The Purchasing Contract
- Escrow Instructions
- The Settlement Agreement (or settlement statement)
- The Deed (preliminary copy)
- Any Loan Documents in the case of a non-recourse loan
Frequently Asked Questions (FQAs) for Solo 401K Real Estate Investment
What is Tenancy-in-Common Ownership?
This provides you with an opportunity to purchase real estate with Solo 401K and personal funds. Ownership will be split per the agreement (50/50, 60/40, etc.). Thus, all expenses and income will be split according the percentage agreement between the owners. This arrangement allows you to invest with certain family members. It is important to follow the percentage split agreement for expenses and income.
What is a Non-recourse Loan?
This allows the Solo 401K the opportunity to obtain a loan from an investor or a bank to purchase Real Estate. Much like normal collateral, if the loan is not paid back, the lender has the right to take ownership of the real estate. However, one very important note is that the lender has no recourse to touch your Solo 401K assets. Only the real estate used as collateral is at risk, not your Solo 401K.
Is it permissble under IRS rules to use a Solo 401K to Invest in Real Estate?
If the Solo 401K Plan Documents allow it, then yes you can use it to invest in Real Estate. A Solo 401K is also referred to as a Self-directed 401K. For a Solo 401K plan, the IRS lists approved investments. Under ERISA, or the Employee Retirement Income Security Act (1974), certain rules apply to investments in retirement plans. Those rules include that you cannot invest in art, gems, antiques, coins, and other collectibles or alcoholic beverages. Although it is permittable to invest in precious metals, if meeting the requirements outlined in IRC Section 408(m).
Can I and what are the rules regarding living in and using a home (even occasional use) owned by the Solo 401K?
Unfortunately, no, it is not permissable. Under the rules and as the owner-employee participating in the Solo 401K, you are considered a disqualified person, by law. If you have an IRA, that rule also applies as well. Others who are considered disqualified persons include your spouse, lineal descendant, any spouse lineal descendant, ancestors, your natural parents, and natural grandparent’s. Furthermore, a disqualified person cannot use the property at all, not even 1 or 2 times a year; it is off limits.
Some who are considered qualified include your sisters, brothers, cousins, aunts, and uncles. This includes a mother-in-law. They would be able to live in the house and pay rent, so long as the rent money went directly into the Solo 401K. You must keep the documentation indicating the renting to your mother-in-law is what they call at an “arms-length-basis.” That simple means that each party is operating independently, essentially no relationship, and without pressure from each other.
As the Solo 401K owner and a real estate agent, if I represent my Solo 401K in a home purchase, can I receive the commission?
No, as you are a disqualified person, which means you or your business cannot benefit from your Solo 401K deal. This holds true for all disqualified persons. It would be in violation of this IRS code:
“The receipt of consideration by a fiduciary for his or her own account from any party dealing with the plan in a transaction that involves plan income or assets.”
If my Solo 401K owns a rental property, would I be able to make needed repairs like replacing gutters, replacing a shower or sink, replacing the hot water heater?
Disqualified persons, yes, this includes you, are not permitted to perform such tasks, paid or unpaid by your Solo 401K. One thing that you are eligible to do, as the Trustee of the Solo 401K, is to manage the property, sort of look after it to ensure it is properly maintained. No, for doing that, you cannot receive any compensation. These activities include things like working with contractors who need to work on the property, collecting rent, writing any necessary checks to cover expenses (these checks would come from the Solo 401K), including real estate taxes.
Can I be reimbursed by my Solo 401K for any travel-related expenses?
Again, the answer is no. Certain funds must be paid by the Solo 401K, like cost of repairs and property taxes, but meals and any travel expenses are not permitted.
If me I or my business have a primary residence, can I sell it to my Solo 401K?
No, as such a sale would break the prohibited transaction rule. Here is the rule, and of course it applies to any other disqualified persons. “The sale, exchange, or lease of property between a plan and a disqualified person is prohibited.”
If I want to invest money in real estate, like a home, can I loan money to my Solo 401K?
Once again, no, as the same disqualified persons rule applies, it would break the prohibited transaction rule. Specifically, it states “You are prohibited to lend money or extend credit to your Solo 401K.” If you wanted to take a non-recourse loan from a bank or some other 3rd-party, your Solo 401K could complete such a transaction.
Can my Solo 401K purchase a building or home?
No, as it would be in violation of this prohibited transaction rule:
“Sale, exchange, or leasing of property between a plan and a disqualified person.”
Similarly, this also applies to what is known as the “round-about or straw-man” transactions. It states that your Solo 401K cannot sell the building or house to a third-party and you subsequently purchase the same property from that third-party. You are allowed to do what is known as an In-kind distribution. Please see the next question about such a distribution.
If I have a Solo 401K and a Self-directed IRA, can I transfer a rental property from the Self-directed IRA to the Solo 401K?
Finally, a yes. IRS rules allow you to transfer or rollover or a direct rollover IRAs. You can take existing IRA assets, like a rental property, commercial building, etc., and move them into your Solo 401K through what we mentioned in the question above, an In-kind transfer. By definition, this is a transfer, not a sale. You can also transfer cash from one to the other. More detail can be found in IRS Publication 590.
If my Self-directed Solo 401K owns a rental property, will I be able to rollover that property over a number of years, into a Roth Self-directed 401K?
I would like to spread any taxes due over those years
Yes, this is another In-kind transfer. With this one, there are rules you need to follow:
- Each time you transfer part of the assets, you will need an Appraisal
- Each time new ownership is established, you must Record the Deed
- You will owe taxes on the converted amount in the year you make the transfer
- You will need to complete an In-kind Roth Solo 401K conversion form
- For each year there is a conversion, you will need a 1099 to report the amount
Can I take a personal income deduction for a rental property depreciation allowance held by a Solo 401K?
No. Depreciation from real estate held by a retirement account is not allowed
Can you explain what is meant by Proof-of-Trust?
Think of this as the trust agreement, the documents, usually around 7-pages, along with the Employee Identification Number (EIN) letter, that outlines and details the foundation of the trust.
Is Liability protection available, if using a Solo 401K to purchase a property?
Yes. You will pay for the Liability insurance through the Solo 401K and you would want to Title the policy using only the name of the Trustee. Another option would be if your name is Sunny Smile and your Solo 401K is Happy Times Solo 401K, it would be titled as follows:
A Solo 401K made a property purchase. What are some key steps I need to complete?
- Ensure all documents reflect the Solo 401K as the Purchaser
- Ensure any Earnest money or cash for the purchase come from the Solo 401K
- Ensure that the Deed is Recorded using the Solo 401K name
Can a Wife and Husband, who both participate in the same Solo 401K, use funds from both accounts to purchase one property, possibly overseas?
Yes, you are permitted to combine monies from the respective accounts. Each spouse should send their funds separately, i.e., not one, but two checks, or wire transfers. You will need to Title the property in the Solo 401K name. A few more key points of interest:
- Expenses and Income can be channeled through just one participant, if that is easier
- Both Solo 401K underlying accounts will need to be reconciled, no less than annually and always when any distributions are processed
- Any reconciliation will need to be aligned with the original ratio between the Wife and Husband (50/50, 60/40, etc.)
- As far as the Solo 401K is concerned, regardless of Domestic or Foreign investment, the rules remain the same, except
- You must adhere to any local regulations and rules. Working with an Attorney in the Foreign Country is recommended so as to not overlook something
- Always use the Solo 401K name, and not any personal names
If a contractor who performs work on a Solo 401K-owned home requires cash, is it permissible to remove cash from the Trust for this reason?
Technically, yes, you could, but it is not recommended. It is possible that in the event of an IRS Audit, such a transaction would warrant a much closer look. The funds from the Solo 401K should flow right to the contractor and not through you first and then to the contractor. It could be perceived as suspicious in nature. If you decide on that approach, be very sure to get and keep all related paperwork and receipts.
Can you create a LLC with funds from one spouse who has a Self-directed IRA and the other spouse who has a Solo 401K?
Yes, there is a way to create such an LLC. Here are the steps you should follow.
- Both the Solo 401K and the Self-directed will need to be used to create the new LLC at the same time
- With this arrangement, Federal Tax Form 1065 and a K-1 will need to be filed for both the Solo 401K and Self-directed IRA, as it is considered a multi-member LLC
- Whenever there are multiple retirement accounts, Form 1065 is required. It is for informational purposes. The Solo 401K and Self-directed IRA will not incur any taxes, as both are tax-sheltered and any rental property investment gains will not result in taxes due until distributions are taken, likely at retirement
- Look for the following services from a third-party if you decide to use your Solo 401K and Self-directed IRA to create a new LLC:
- Filing of the Articles of Organization with the Secretary of the State
- From the IRS, get the Employer Identification Number (EIN) for the LLC
- Creating the Operating Agreement for the LLC, which would include the Solo 401K, the Self-directed IRA, and required IRS language
- Help with opening the LLC bank account
- Ensuring the Solo 401K and Self-directed IRA regulations are followed
If we have an investment home in our Solo 401K, can we use personal cash outside of the Solo 401K to make repairs? Once the property is sold, can we be reimbursed for repair costs?
Since the home is owned by the Solo 401K, it is considered a prohibited transaction, so the answer is no
Via Tenants-in-Common (TIC), can we buy a multi-family unit, using the Solo 401K, and live and occupy one of the units?
Unfortunately, no, since the Solo 401K is the owner of the property, you cannot access it for business or personal use
If I own a rental property that is not my primary residence and is not associated with my Solo 401K, would I be able to either Quitclaim Deed or Sell (below market value) that rental property to my Solo 401K?
No, such a transaction would be prohibited according to the following rule:
“The Sale, Exchange, or Leasing of property between the Plan (Solo 401K) and a party in interest (your business or you).” You simply cannot transfer property you own to the Solo 401K, irrespective of above-or-below market value.